Loan Structure – Your loan is made up of more than just a monthly figure

In the past two reports I’ve looked at the often-unclear differences between finance agreements available in the car sales market. Judging by the numerous replies that arrived in my inbox, many of you feel under-advised on the full detail of your loan quotation, and unsure of why you are being quoted a certain way.

With so many different deals available, particularly when it comes to car finance, I thought we’d take a detailed look at loan structure.

A hire purchase agreement is a standard legal document. It is designed to be legally compliant and commercially beneficial for the lender whilst offering protection for the consumer.

In recent years the cost of money has remained low making interest rates competitive, so why is there such a big difference in monthly payments for different goods?

The answer lies in the type of products you are borrowing against.

Typically, a new car loan will be offered at a lower interest rate thanks to manufacturer subsidies to entice you into buying certain models. Have you noticed how desirable, low production cars can never be found with 0% finance?! Often the most competitive rates can be found on used cars, which will be up to ten years old at the end of an agreement.

This can cause a problem to those of us in a specialist area of the lending business.

Recently I was asked to quote on an amount of money for a client, who seemed antagonised when I asked what the money would be spent on. “I just want a quote, not a sales pitch” he replied… it seemed obvious to me that this client was ‘doing the rounds’ to find the cheapest monthly payment, rather than considering what the structure of his loan should be, or whether it was right for his future with the car.

So, what factors affect the monthly payment? Really, there are three key areas to consider. Deposit, Loan Length and Balloon Payment.

A couple of television ads recently caught my eye… It had me wondering, how can it be that a premium Volvo SUV is advertised with a similar fixed monthly payment to a Hyundai estate car…? The answer lies in our three key areas.

Deposit

The deposit is a crucial factor of any loan, which creates what we all know as the Loan To Value (LTV) ratio. A smaller deposit will mean a larger loan, and a larger deposit a smaller loan… Who is the overall beneficiary of that? A lender may entice consumers with “no money down” or “£99 deposit secures any car”… Is this a helping hand for the hard up consumer or a way to push up the amount of funds lent?

Length of Agreement

Our second point to consider is the length of the agreement. Astoundingly I am beginning to see 10-year profiles being offered in the classic car market. Ten years is a long time to repay any loan, we’d normally associate that length of loan with a mortgage not a Maserati. A lot can change in 10 years; let’s not forget the legal statement “The value of your investments can go down as well as up”! This is very important when it comes to classic car ownership. Did you buy it as an investment, an heirloom, a weekend toy…? Will you be hankering after something different in 3 years time, or is this a car you intend to keep until ‘death do us part’?

Balloon Payment

Our third point is one of the key drivers of the cheap finance deals we see advertised. One I heard on the radio last week was a 2018 Ford Fiesta for something like £169 per month over three years, which sounds very cheap as a headline grabber but the detail is in the balloon payment… Sure enough, after 3 years you are left with just over £6000 as a lump sum payment to clear the loan. When you’ve paid £13,000 for a car with a retail price of £12,000 and a three year old used book value of £7,995 it doesn’t look like a great position to be in…! This is known as a balloon payment. As consumers, it’s easy to get caught up in ‘go fever’ and neglect the future consequences of a financial agreement.

When combined with the deposit at the front of an agreement, the balloon payment also affects the LTV of any money lent and therefore the cost of your loan.

We see many loans advertised just like the one detailed above… a cheap monthly rate with a significant balloon payment, but when the interest is calculated on the whole sum borrowed, what is the benefit of this ‘cheap’ rate, and who is the ultimate beneficiary?

So, when you are going to the market to find the ‘best deal’ for your finance needs, be sure to consider more than just the interest rate.

The three areas we’ve talked about make up the Structure of your loan, and being clued up on how your loan works and having a good idea of what will suit your needs, your lifestyle and the plans you have to spend the money will make the whole experience much more beneficial… for you!

Summary:

Make sure you have a good understanding of the overall cost of the finance, including the interest charges